The COVID-19 crisis has been particularly harsh on the financial sector, especially among real estate investment trusts (REITs). The mortgage REIT sector has been absolutely crushed, and retail/mall REITs are suffering as many stores remain shut. The apartment REIT sector has not been immune either, and it is experiencing higher delinquencies.
All that said, things might not be as bad as feared just a month or two ago.
First-quarter earnings increased
Equity Residential (NYSE:EQR) earlier this month reported first-quarter earnings of $0.83 a share, compared to $0.28 a year ago. Funds from operations increased 6% from $0.82 to $0.87 per share. Delinquencies ticked up to 5.4% from 2.6% at the end of March; however, this is much better than the typical apartment REIT performance. According to the National Multifamily Housing Council, almost 20% of renters have missed their payment in the first week of May. This is largely because Equity Residential leases upscale apartments to younger professionals in the knowledge industry, who seem to be less affected by the COVID-19 crisis as they are most likely to be able to continue to work from home.
On the conference call, CEO Mark Parrell described the current state of affairs this way:
The best way I can describe it in the last seven weeks is resilient. In April, we collected in our residential business about 97% of the cash that we would usually collect. While no part of our country's economy will be immune from the coming recession, we feel that our portfolio of properties, populated with residents having average annual household incomes of $164,000 and often employed in technology and other knowledge industries, will fare relatively well.
Traffic and applications are almost back to normal
Interestingly, the financial environment for Equity Residential improved during April. Traffic and leasing activity increased 30% during the month and is now roughly on par with a year ago. In the last week of April, the company had over 900 applications compared to the 375 it received in the last week of March.
When the shelter-in-place orders first began in mid-March, application activity was down 50% on a year-over-year basis. In terms of markets, Seattle and Denver were the strongest with delinquency rates below 3%, while Los Angeles was the worst at 8%. High-rise urban properties are performing better than the suburban garden-style properties. New York City is a bit of a mixed bag, with tight supply, although applications and traffic have yet to recover.
Despite the strong performance in residential, the non-residential portion of Equity Residential's portfolio saw some softness. The non-residential portion includes ground-floor retail, which had a 58% collection rate in April, and non-resident parking, which saw a 30% decline in volume. Drugstores, banks, and national chains comprise the majority of the tenants, and they performed the best. Small business tenants are suffering.
Equity Residential trades at a 4% dividend yield, which is at the high end of its range. At the current level, Equity Residential has a 69% payout ratio, which gives the company some breathing room if delinquencies tick up.
While it is hard to fall in love with stocks in the financial sector at the moment, Equity Residential is probably one of the better candidates. Its business model involves owning properties targeted toward affluent professionals in urban areas with a tight supply of housing. The fact that applications and traffic have recovered to flat on a year-over-year basis is encouraging.
If the COVID-19 crisis is largely in the rearview mirror, Equity Residential should be one of the first REITs to recover. That said, it is hard to love credit exposure (and rentals are credit exposure) going into a recession. This stock would be one to watch and pick up once we have a clearer picture of COVID-19's overall effect on the economy.